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Monday, February 1, 2010

I agree, in a different way

Reading Paul Volcker's opinion in the NYT, its hard not to agree with him. Simply put, he is right. But I fail to see how a large over leveraged hedge fund under the GS umbrella would cause less harm than one that is independently owned. Case in point, Long-Term Capital Management (LTCM).

LTCM was a large over leveraged fund that sent a shock wave through the entire system when it was failing. The fact that it was independent meant nothing. It was large, and over leveraged. That is the key here.

The tools are available to prevent, too large and too leveraged. For starters:

1. all trading vehicles must go through a clearing house. (to ensure margins and capital requirements are met. This must be a requirement prior to given the approval to trade.)

2. the less liquid and more exotic the trading vehicle the more capital is required. (The holding company should not be taken into consideration w/respect to the capital requirement. The capital requirement must come from the subsidiary trading, as the subsidiary will be the company that can then fail without systemic risk.)

3. the new regulator must have power over any company, regardless of title, if the company is 'trading' any vehicle. The regulator should approve the ability of the company to trade and should actively monitor capital levels with respect to potential losses. (To prevent another AIG situation)

I definitely agree with Mr. Volcker, I just do not see how breaking up banks for the sake of making them smaller will do anything. But for those banks that can not have their trading subsidiaries have sufficient capital requirements, to prevent failure of the entire bank, then the trading subsidiary must be independent or raise capital.

And we, as a society, can not have this new regulator asleep at the wheel, they must be proactive regulators.